Islamic State, Islamic Economy, and Siyasah Syariyah:

An Islamic Political-Economy Approach

Diyah Putriani1
Saim Kayadibi2
Tita Nursyamsiah3

Abstract
This research paper is intentionally designed to build a framework of Islamic economy into one picture
of Islamic state concept. The research paper employ quantitative and historical approach. The result of geometric
mean computation showing the growth of money supply in Iceland is higher than the growth of real GDP and the
the inflation rate reaches 18.91 percent. The regression analysis is carried-out based on natural logarithm (Ln)
model. The estimated coefficient of M1 in Iceland is much higher than the estimated coefficient of GDP. This
result also supports the finding of geometric computation. In other words, there is an economic problem in
Iceland created by the working of compounded fiat-money interest rate. It has implicitly proven that since the
power of Islamic government is absent in this world, then the Islamic state will never be established. Therefore,
the need of siyasah shariah to build Islamic government before establish Islamic state becomes an obligatory.
Keywords: Islamic Economy; Islamic State; Islamic Welfare; Siyasah Shariah; Maqasid al-Shariah.

1.1. Introduction
During 2008 to 2011, European countries were in amidst of badly debt crisis.
Economic crisis is viewed in Islam as a corruption (fasad) due to the disobedience of
a man to God who thinks that there is no judgement after this life in the world

1
M.Ec student, the Department of Economics, Faculty of Economics and Management Sciences,
International Islamic University Malaysia, Kuala Lumpur. Email: diyah.putriani@gmail.com.
2
Associate Prof. Dr. Saim Kayadibi, the Department of Economics, Faculty of Economics and
Management Sciences, International Islamic University Malaysia (IIUM), Kuala Lumpur. Email:
skayadibi@yahoo.com
3
M.Ec student, the Department of Economics, Faculty of Economics and Management Sciences,
International Islamic University Malaysia, Kuala Lumpur. Email: tsyamsiah.280188@gmail.com

1
(duniyah). The fall of economies in many countries into debt crisis becomes a proof
how human being disregards his function as a vicegerent (khalifah) who carries trust
(amanah) solely for worshiping in the sake for Allah SWT. Man, henceforth, is
created to be a vicegerent of Allah along with trust bear on him in the earth. The debt
crisis fundamentaly come up from the creation of money through fractional reserve
banking, compounded interest rate, and seignoirage. Not only it affects negatively in
the economic sector, but also it significantly influences the whole life of human
being. Unfortunately, these facts still unable to eliminate interest rate in the economy
activites, both in individual and state level. This issue has been discussed not only in
Islam, but also in Judaism and Christianity. Pro-usury (riba/interest rate) groups have
belived that usury is a main foundation and a part of global economic system. They
argue that interest rate is an obligatory due to it compensates those who sacrifice their
consumption now for some potential future profit, i.e. it is designed to protect
investment from the effect of inflation. Thus, interest rate becomes the price of
money and still rationale to be existed in the economy.
Islam discourages a moslem borrow money due to irrational reason, for
instance, to follow the modern life style. Unfortunately, since the rise of western
world and the detriment of moslem world, the issue of debt becomes wider. In the
later stage after the moslem live in backwardness, the interest rate is legaly imposed
on debt. Debt now is somewhat called as a lifestyle and it has many impact on
socio economic life. Credit card, for instance, becomes a thing that must be had,
particularly for modern executive. Therefore, the elimination of interest rate in the
economy becomes a major agenda in the economic system. The absence of Islamic
power to intervene the establishment of free-interest economic system constitutes as a
main reason why does this system still remains in the level of discussion. It is
impossible to implement the ideals of Islamic sociopolitical and economy, establish
Islamic law, education and civilization without Islamic state (Syukri, 1999). The
order to do good deeds and avoid the harms will be wholy apply if there the power
and authority exist in the social activities life. In other words, the Islamic political

2
instrument must be built in the form of a Islamic nation (state) which will ensure the
the maximization of universal common good, e.g. promotion of public welfare and
enforcement of law.
Reffering to this background, hence this research paper is intentionally
designed to build a framework of Islamic economy into one picture of Islamic state
concept. Since politic and economic are two sides of a coin, hence this research paper
is designed to combine the economic and political matters in order to build islamic
state. The writing organization of this research paper will be classified into 5 parts.
Part 1 explores the background of the research. Part 2 shed light on the rising issues
come up in moslem countries, namely siasah syariyah, khilafah and Islamic Finance.
Part 3 summarizes previous literatures related to the concept of Islamic State,
shariah governance and maqashid al-shariah. Part 4 analyzes the rising issues from
Islamic point of views and construct to build a framework of Islamic economy into
one picture of Islamic state concept. Some conclusions and policy implications are
presented in Part 5.

1.2. Paper Contributions

Many previous research focus of research in Islamic economics is concentrated on the
function of Zakah, Infaq, Sadaqah, and case study of Sharia Banking. In the other
words, only few of conducted researches in Islamic economics are explored by
involving Islamic political approach. Therefore, this study will especially contribute
to fulfill the gap of literatures in Islamic economics and politics analysis.

2. Literatures Reviews
2.1. Shariah Governance4

4
Summarized from Putriani, Diyah; Warsono, Sony; and Amalia, Fitri. 2012. Corporate
Governance and Shariah Governance: Revisited Three Basic Elements of Shariah

3
Allah is the creator of this universe. Only Him who knows the needs of all His
creation since He has perfect insight to protect of what presence on the earth and in
the heaven. Allah, thus, has an eternal attribute of divine (great) and absolute right to
govern His creation. For the glory of Allah, the highest knowledge is placed in His
hand.There is none same equal to Him. These perfect insight of knowledge,
governance, and protection from Allah The Almighty which is called as the divine
governance. Ibn Arabi (1997) in his book explains that the creation of universe is a
greatness (the gifts) of Allah for mankind. The divine governance, hence, focuses on
how Allah directs human beings by bestowing them a guidance of light in life (Al-
Quran), setting His unity in the hearth of man, and supervising to find Allah. The
belief that Allah is the absolute ruler who perfectly manage the entire universe will
direct a man to understand divine governance. Shariah governance, in this context,
refers to the concept divine governance. Therefore, every individual needs to learn a
basic understanding of the oneness of God.
Knowest thou not that Allah knows all that is in heaven and on earth? Indeed it is all
in a Record, and that is easy for Allah.5
Say: He is Allah, the One and Only! Allah, the Eternal, Absolute; He begetteth not
nor is He begotten. And there is none like unto Him.6
The relationship between the oneness of God and divine governance lies on the
confession of a man against the existence of God as the sole creator and director for
everything that presence in this world. In Islam, this relationship is known as an
aqeedah (faith of monotheism doctrine). Ibn Arabi (1997) elucidates that the
abjuration of oneness of God is a form of ignorance. It implies that the oneness of
God is basic foundation, hence, every believers must understand of oneness of God in
all aspect of their worldly life.

Corporate Governance Framework. Paper presented in 5th International Conference on

Islamic Banking and Finance. Amman, Jordan: October, 6th-8th 2012.
5
QS. 22: 70
6
QS.112: 1-4

4
When thy Lord drew forth from the Children of Adam - from their loins - their
descendants, and made them testify concerning themselves, (saying): "Am I not your
Lord (who cherishes and sustains you)?"- They said: "Yea! We do testify!" (This), lest
ye should say on the Day of Judgment: "Of this we were never mindful"7
Praying without believe in faith (aqeedah) will not be admitted by Allah.
Here, a one who has a strong faith will do praying, do good deeds, and do economic
activities (muamalah) in line with Islamic values. It means a right aqeedah will
direct a moslem do implement Islamic rulings in his daily activities. Historically,
Rasulullah SAW even focused only on his preaching by building a hefty aqeedah
during 13 years of his periode of life time in Mecca. Thus, in the next period of life in
Madinah, Rasulullah SAW could easier deliver the true message of Islam.
Recite, [O Muhammad], what has been revealed to you of the Book and establish
prayer. Indeed, prayer prohibits immorality and wrongdoing, and the remembrance
of Allah is greater. And Allah knows that which you do.8

2.2. The Islamic Concept of State and Welfare

Islamic state is a community based on belief. It implies that the Islamic state
constitutes as an ideological state confirming the application of shariah governance
in all of members life aspects. The significance of Islamic state is pointed on the
establishment of Islamic order in the moslem society. When the Quran reveals of
rules and laws, the very fact that these rules are mentioned and meant for
implementation shows that there has to be an authority to carry them out. Therefore,
it is proposed that for the moslem ummah, the establishment of an Islamic political
order or an Islamic state is part of the implementation of faith. The Islamic state is
empowered as a political instrument for ensuring the enforcement of law, human
rights, and Gods will (Islamic values). In detail, the goals of Islamic state are to
prevent injustice and to establish all-encompassing justice-legal, social, economic and

7
QS. 7: 172
8
QS. 29:45

5
political, including to ensure to all non muslim citizens complete physical security as
well as complete freedom of religion, culture and social development. Hence, the
teaching and preaching of the message of Islam can be delivered to whole ummah.
It is impossible to implement the ideals of Islamic sociopolitical and
economy, establish Islamic law, education and civilization without Islamic state
(Syukri, 1999). The order to do good deeds and avoid the harms will not be
comprehensively implement if there is no power and authority. In other words, the
presence of politics based on Islam (siyasah syariyah) must be first applied. Since
Islam guarantees for attaining welfare in this world and hereafter, hence, the Islamic
state becomes an instrument to realize the spiritual in human organization.The state
technically operates by institutionalizing shura as a consultation-consensus model.
The principle of shura was revealed in the late of Mecca period which Al-Quran
confirmed and incorporated in Islamic values. It was a concesus institution in terms
of a counsultative council or assembly where tribal and political leader decided
collective decisions after discussing the problems happening amongst themselves
(Haq, 1991).
In fact, present system of politics the opportunity for Islamic state to be
established is eliminated. Silent of Islamic politics means absence of Islamic
civilization, including Islamic economy. Unfortunately, the existing economic system
can not solve many human problems of economic. In this admist of fluctuation, the
birth of Islamic economics as a new paradigm in conventional economics theory
offers an alternative hope for the elimination of misery. Khan and Syed (2009)
reveals that the fiasco of capitalism is obviously observed, i.e., it remains a small of
minority achieving unprecedented high material standards of living, yet there is a vast
majority of the people on the globe live under conditions of abject poverty. Here,
capitalism recognises the absolute individual freedom. On the contrary, socialism
refuses capitalism doctrine and offers the absolute role of government in individual
life, including in economic aspect. In fact, the market of socialist countries have
already flooded by capitalist countries product. In all probability, the outcome will be

6
no different since they will keen to adopt the capitalist lifestyles as well as economic
strategies.
Since capitalism and socialism are established by human who unbelieve to the
existence of Allah, hence only Islamic economic offering a comprehensive solution
for all of human economic problems. In other words, Islamic economic is not an
alternative solution, but it is the only solution for all of these chaotic. Islam, in this
context, offers two dimension protections of moslem ummah rights and obligations,
both materially and morally. The Islamic system of protection, according to Jauhar
(2009), is widely known as maqashid al-shariah or the very objective of Islam
which covers five basic elements of life (al-kulliyat al-khams/adh-dharurat al-
khams). The Maqasid al-shariah underlines the concept of maslahah which is
includes the enhancement, preservation and safeguarding of five basics (Usul). The
ultimate goal of maqashid al-shariah covers the lives of individual and society at
large; in this world and hereafter. It implies that maqashid al-shariah must be
understood as a comprehensive image of Islam.
Khan and Syed (2009) explain that moslem jurists have unanimously herld that
catering to the welfare of people and relieving them of hardships is the basic
objective of the shariah, hence of the Islamic state. It implies that the concept of
Islamic welfare state is derived from the very objective of shariah or maqashid al-
shariah. Shariah literally means the flow of water. The concept of Shariah regulate
two wholly technical aspect, i.e., ibadah (worshiping) and muamalat (the rules
related to worldly activities, e.g. economic, social and politics). In other words, it
implies that the law of Allah is created to governs humans relationship with Him and
others. Islamic teaching, hence, encompasses all of peoples life at large (Warsono
and Jufri, 2011; Khir, et.al, 2008).
In detail, Al-Ghazali divides a binding of maqashid al-shariah into five
safeguardings, namely life (sovereignty), faith, intellect, posterity, and wealth (in
Meera and Larbani, 2009). Everything that add a utilization to five basic things is a
Maslahah (benefit), and vice versa everything that give bad effects to them is a

7
Mafsadah (harm). The urgency of maqashid al-shariah is to achieve the glory
(falah). Government, as uluamr, must protect these five elements in order to pursue
the blessing of Allah and to attain the welfare of moslem ummah. Quoted from Khan
and Syed (2009), the welfare function of the Islamic state was particularly stressed by
Prophet (PBUH) when he stated Any ruler who is responsible for the affairs of
moslem but does not strive sincerely for their well-being will not enter paradise with
them.
Unfortunately, there are so many ruler and moslem scholars advocating the evil
of interest (riba) which has been strongly promoted by capitalism, but prohibited by
Islam. The presence of interest in the economy will inhibit the objective of shariah
due to its harm the economic justice. In brief, Khan and Syed (2009) elucidates that
the welfare of individuals as well as society in an Islamic state may be attained if
there is proper environment for a fuller realizes the values of Islamic spiritual and
satisfies of all basic needs of life.

2.3. Rising Issues in Moslem Countries: Islamic Economic and Siyasah Shariyyah
Every country usually has its own regulation related to law, politic and economic
strategies. Some of moslem countries apply shariah principles to regulate their
states. In this context, a broad docrine of Islamic law which authorizes the ruler to
determine the manner of which shariah must be administered is called as siyasah
shariyyah 9 . According to Ibn Qayyim, any measure which actually brings the
people closest to beneficence (salah) and furthest away from corruption (fasad)
partakes in just siyasah even if it has not been approved by the Phophet (PBUH) nor
regulated by Divine revelation. Any one who says that there is no siyasah shariyyah
where the shariah itself is silent is wrong and has misunderstood the companions....
(p.61). Related to siyasah shariyyah, the belief of Islam encompasses all aspects of a

9
Ibn Qayyim in Kamali, Mohamad Hashim. 1989. Siyasah Shariyyah or the Policies of
Islamic Government. The American Journal of Islamic Social Sciences, vol.6 No. 1,1989
pp. 59

8
Moslems life, causing the articles of their faith and the relationships between man
and God, and between human beings in which Islamic law regulate in Shariah
principles. Islamic law or Shariah as revealed in and derived from the Quran and
Sunnah rules all politic, economic and social activities and works of Moslems.
For over time, Islamic economics model has been developed which is based on
the rulings of Shariah on commercial and financial transactions. The Islamic
financial framework as seen today, stems from the principles developed within this
model, some of which are outlined as follows (Ainley, et.al, 2007):
The Islamic economic model emphasises fairness. This is reflected in the
requirement that everyone involved in a transaction makes informed decisions
and is not misled or cheated. On a macro-economic level, the Islamic model
aims at social justice and the economic prosperity of the whole community;
for example, specific Shariah rulings seek to reduce concentration of wealth
in a fewhands,which may be detrimental to society
Islam encourages and promotes the right of individuals to pursue personal
economic well being, but makes a clear distinction between what commercial
activities are allowed and what are forbidden. For example, transactions
involving alcohol, pork-related products, armaments, gambling, and other
socially detrimental activities.
One key Shariah ruling on economic activities of Moslems is the stricly
prohibition of riba. Shariah scholars consider exchanging interest payments
within the conventional banking system as a type of riba. Modern Islamic
banking has developed mechanisms to allow interest income to be replaced
with cash flows from productive sources, such as returns from wealth
generating investment activities and operations. These include profits from
trading in (real) assets and cash flows from the transfer of usufruct (the right
to use an asset), for example, rental income (Bahrain Monetary Agency,
2002).

9
 The aplication of Islamic economic can be seen in Islamic finance and banking.
In terms of history, Islamic finance started in earnest in the 1970s with personal
initiative of the concerned Moslems to address the problem of riba. Its growth has
been accelerated in case of some countries that operate and also the areas of finance
which has been exerted. But one of the problem is some of reliable data are not
available in case of Islamic finance at the country, regional, or global levels. In
current years, many Western multinational financial institutions such as Citigroup
and HSBC that estabilished offering Islamic financial products in some Arab
countries (especially Bahrain and UAE) and also to a lesser extent in Western world
((including the USA and UK, where HSBC offers various Islamic financial products
in New York and London, including home financing, checking accounts, etc) have
been attracted by this industry. Dusuki and Abdullah (2007) find out how to
distinguish between Islamic banking paradigms and model to conventional banking.
Islamic banks purpose to create a fair and balanced society as prescribed by the
Islamic economics. Choudhury and Hussain (2005) state that since the twentieth
century Islamic banks have emerged and they rely on the resources based view to
offer banking services. All financing instruments are based on the Islamic law. The
prominent idea of Islamic banking is the prohibition of interest and profit loss
sharing. Ghannadian and Goswami (2004) state this by conforming that the main
Islamic banking principles are risk and profit loss sharing.
Furthermore, nowadays Islamic finance has spread to some areas in Asia, and
it has grown fast in Eastern of Asia especially Malaysia. This country became the first
to found the Islamic Inter-bank Money Market (IIMM), the full-fledged Islamic stock
broking company, the corporate sukuk (Islamic bond) and the Islamic unit trust.
However, there is such a pro-contra opinion in Islamic banking in Malaysia since its
government allows bay al-inah or buy back sell transaction. The Malaysian
shari'ah scholars validate the practice of bay al-inah based on two

10
 main justifications 10 . Firstly, they state that the contract is not clearly prohibited
either in the Quran or in the Sunnah. They do not admit the validity of the
hadith which indicate the prohibition of the contract.
Secondly, the Malaysian scholars argue on the basis of maslahah, in which
refers to the need of Moslems contemporary society. The scholars admit the argument
that, for instance, credit card has become an important banking facility for majority of
Moslems. In today's world, the card is important for daily business dealings and
commercial transactions. Wondering this case, the scholars support the bank's idea to
create a credit card that is shari'ah compatible. In this terms, bay al-inah is seen as a
key contract due to it provides a makhraj (mode of problem solving).
In this case, bay al-inah implemented in Malaysia mosly is due to the rulers
analyse this contract will bring maslahah to arouse Islamic banking in Malaysia,
particularly at the first periode of Islamic banking estabilished. In perspective of
siyasah shariyyah itself, any measure that brings people closest to maslahah and
furthest away from mafsadah partakes shariah, even if it has not been proved by
Prophet (PBUH) and Divine relevation. 11 Bay al-inah as perspective of Malaysias
government has brought any maslahah those mentioned above. In the other country
such as Bangladesh, Islamic banks have been operating in Bangladesh for about one
and half decade alongside with the conventional banks.12 Out of over 39 banks only
five banks (including one foreign Islamic bank) and two Islamic banking branches of
a conventional bank have been working on Islamic principles. Such as any other
conventional banks, they do manage deposits and produce loans. But their modes of
operation, based on shariah principles is different from the other conventional

11
According to Ibn Taimiyah in Mohamad Hashim Kamali, Siyasah Shariyyah or the
Policies of Islamic Government, (The American Journal of islamic Social Sciences, vol.6
No. 1,1989) p. 59
12
Sarker, Md. Abdul Awwal. Islamic Banking In Bangladesh: Performance, Problems &
Prospect. International Journal of Islamic Financial Services Vol. 1 No.3.

11
banks. However, the five Islamic banks operating in Bangladesh are Islamic Bank
Bangladesh Limited (IBBL), Al Baraka Bank Bangladesh Limited (Al-Baraka), Al-
Arafah Islami Bank Limited (Al-Arafah), Social Investment Bank Limited (SIBL),
and Faysal Islamic Bank of Bahrain EC (FIBB) .

3. Data and Methodology

Given the objective of the present researches, data requirement and the availability of
time and resources, this study is gathered data from secondary sources, such as
Central Bank of Iceland, and International Financial Statistic International Monetary
Fund (IFS IMF). This research will employ both of quantitative and qualitative
methods for analyzing data and object of study. In short, the qualitative method
applies historical approach and policy study analyzes in order to strengthen the
analysis. Meanwhile, the quantitative methods cover financial and econometric
analysis as follows.
Financial analysis is applied in order to explain the economic conditions and to
proof the negative impact of the presence of interest rate in the economic system. To
do so, this research will observe macroeconomic of Malaysia as a case study. The
geometric mean of both money supply (M2) and the geometric mean of real GDP are
computed, as follows:
FV = PV (1+i)n (1)
where,
FV : Future value
PV : Present value,
i : Interest rate
n : number of years.

After calculate the geometric mean, then we compute the inflation in Iceland, as
follows.

12
 1 Geometric mean for M1
Inflation (2)
1 Geometric mean for G P
The Ordinary least square (OLS) as an econometric model will be used for
assessing the estimated coefficient. Both M2 and real GDP are measured in natural
logarithm (Ln) in order to smoothen the results. Each of M2 and real GDP are
regressed through the time aimed to capture the trends of those variables over 10
years. The econometric model used in OLS are built as follows:
Ln M1 = 0 1t (3)
Ln Real GDP = 0 1t (4)
where,
t : time as the data collected from 2000 until 2010
Real GDP: Measuring the real economy.
M2 : Consisting M1 plus short-term investment accounts such as time
deposits, money market deposits accounts, money market mutual
fund shares.

Notice, if the coefficient of M2 is bigger than the coefficient of real GDP, thus
the country is occuring severe economic problems, i.e., money supply grows much
faster than real GDP. In other words, it indicates that the real side of economy
incapable to compete with the monetary side of the economy and leave the country
with several economic problems.

4. Islamic State and Islamic Economic: A Preliminary Framework

4.1. Islamic Government Towards Islamic State
Islam nowdays plays different roles in the governments of countries where moslem
are in the majority. Its role in government, however, varies widely even in
predominantly moslem countries. Lineback (2005) divides the role of Islam into four
categories as follows. Amongst 44 moslem countries around the world, 10 are
declared Islamic states meaning that Islamic law is deeply applied into the

13
constitutions of these countries, including the obligation for women to cover their
bodies from head to toe. There are 12 countries that have declared Islam as the state
religion, but whose civil laws do not specifically follow shariah. The ulema (clergy)
is powerful in these countries, but not all powerful. These countries may have civil
courts that are independent from the ulema and government officials who are not
clergy. The harshest forms of shariah are typically avoided and governments tend to
be more liberal toward personal behaviors than those in Islamic states. These first two
groups are considered the core of Muslim counties across southern Asia and North
Africa. Next, in the third category there are 11 states whose constitutions simply do
not declare any religion, hence some Islamic laws are not applied. These 11 countries
are located peripheral to the geographic core of Muslim states. Finally, the fourth
group includes declared as secular states whose constitutions acknowledge the
diversities of religions within their borders, so that adherents of all religions have
some constitutional rights. This is a very significant issue because minorities are
afforded some protection under civil law.
Reffering to these categorization, it implies that Islamic state will be
established since the agent deals with Islamic values, i.e. Islamic government.
Although, there are 10 countries declared as Islamic state, however, the presence of
interest rate in the moslem countries economy has implicitly proven that the power of
Islamic government is absent in this world. Here, the need of siyasah shariah to
build Islamic government before establish Islamic state becomes an obligatory. Since
the politic system is under Islamic law, hence the governance of all transactions in
society will invoke with shariah rulings, including economic activities. In this
matter, Islam concerns on the establishment of an economic system in order to
guarantee the sustainability of two broad elements, i.e. (a) accomplishment of basic
needs for all individual within society including those who may be incapacited or
handicapped and (b) a fair reward of extra comfort elegance to the superior skill and
enterprise through lawful means. The basic needs, specifically, are food, clothing, and
shelter (Khan and Syed, 2009).

14
4.2. Islamic Government and Islamic Economy
Historically, under the reign of caliphate Sayyidena Omar Ibn Al-Khattab, the
economy of moslem ummah was a resource-surplus. In this case, fiscal policy
effectively worked and became one of the economic engine through foreign trade
expansion. Meanwhile, monetary policy was not intensively applied to stabilize the
economy. The economy worked in real things and the politics system was applied
under the rule of Shariah. As of Tahir (2011) explains that international trade and
mobility of resources provide a natural huge opportunities for building networking
with the foreigners and spreading the word of Allah SWT to the world. Government
might work toward opening of the economy through developing economic protocols
and agreements. In other hand, the economic system of capitalism in recent day is
designed for those who greed towards the worldly things. The welfare will never be
hold particularly for moslem ummah13. Meera and Larbani (2009) reveals that the
seignoirage of fiat money, the fractional reserve banking (FRB) and interest rate
constitute the root cause of uncontrollable fluctuation in the economy creating crises
in many countries since this system has been implemented.
Many ummah in moslem countries fall under the poverty line. Since interest
rate was introduced in the economy and the monetary system was changed from gold
base to fiat money, the whole economy of moslem countries is then somehow
controlled by the riba-system. A gap between real and financial sector becomes much
larger and the economic growth is driven by financial sector, e.g. secondary market
activities creating bubble economy. Either the economic crisis of Southeast Asia
region in 1997 or the occurance of environment disaster today are the obvious
product of this system. In this case, reffering to Hardi, et.al. (2012) the root cause
of natural calamity in Indonesia deforestation is originally created by human

13
Ummah refers to society of moslem.

15
beings decission. Since the government, as the uluamr, agree to deal with economy-
interest rate based, thus the created disaster will never be avoided.
The two broads elements, as stated earlier, will never be attained under the
economic of capitalism as prevails today creating chaotic situation. Islam has
prohibited money to be treated as commodity. Unfortunately, the fiat money refers to
paper money used widely around the world since the demise of the Bretton Woods in
1971. This fiat money does not have intrinsic value since it does not backed or
redeemable by gold. The printing of fiat money enthrones its creator immediately has
purchasing power without bearing any risk. Seigniorage constitus the benefit derived
from the first use of fiat money. Meanwhile, the FRB means a commercial bank
needs to hold a fraction of the deposits of its customers as reserve, while the
remaining can be lent out (Meera and Larbani, 2009). The current instability in the
existing economic and monetary system is due to the presence of interest rate. Here,
interest rate plays important role that become the engine of this system instrument.
The work of FRB, stock or arbitrage activity in banking industries and secondary
market will be nothing if there is no interest portion on it. By employing interest rate
on the financial instruments, hence it will create ownership out of nothing, without
effort and risks, especially for the lender and broker.
Considering these matters, government officers particularly in moslem
countries should act as an ulual amr who supervise and regulate the economy and
social activities in line with shariah. It implies that government might not become
an economic agent i.e., it is forbidden to be involved in the economic activities. It is
an unfair trade if government is allowed to be a player in the economy due to they
will benefit their power for regulating market deals with the main economic purpose,
i.e. earning profit. However, Islam does not neglect the role of government to
interfere in the situation that might lead to injustice or disputes among the market
player. Besides, the market regulation must observe the shariah rules and regulation
in any of its economic transactions. The silent of ulual amr will cause instability in
the society, e.g. the presence of interest rate in the economic system as explained

16
above. To this end, government officers as an ulual amr must know the shariah
rulings in all aspect since he will also act as an agent who directing the life for
moslem ummah. In fact, in the early era of Islamic state under Prophet PBUH until
for Caliphs, the election of leader (government) became a crucial agenda. All of for
caliphs basically did not want to be an amirul mukminin (leader of Islamic state) since
they realized that the tasks of government are very serious and hard. .
Generally, Kahf (2000) elaborates the aims of Islamic government in the
economy is constituted from the economic objectives of Islam itself as a way of life.
Basically, the economic objective in Islam is based on 2 (two) main involved sectors
directly, i.e., private sector and public sector. Meanwhile, philanthropic sector might
be regarded as indirectly economic sectors which enables the government to generate
revenue through zakah, infaq, sadaqat and awqaf since the taxation is not a rule. In
Islamic system the economic objective for private sector i.e. individuals system are
to comply with the individuals basic needs and wants by earning sufficient income,
and to construct welfare and prosperity on the earth. 14 Meanwhile, the economic
objective in Islam for public sector i.e. Islamic Government can be classified in two
general tasks. The first task is to encourage the private sector to attain material joy,
construction, and welfare. This attainment can be acquired by controlling and
monitoring the economic activities of private sector in providing basic needs to
individuals. If necessary the Islamic government shall fill the gap of production and
distribution. The second task of economic objective in Islam for public sector is to
safeguarde the moral value of shariah in economic activities and promoting the
boundaries of what is known as good and as bad. To do so, the government shall
establish Al-Hisbah (ombudmanship).
Kahf (1991) and Islahi (2008) further explain that the function of al-hisbah is
aimed to control the activities and transactions of the market from three sides, namely
(a) all of activities and transactions must under the rules of shariah, (b) all of

14
Al-Quran verses 11:61, 30:9, 9: 19 and 52:4

17
activities and transactions have to fulfill the moral value of Islam as a belief system
(c) the ombudsman (Muhtasib) is also assigned with the task to ordain what is
known as good and as bad. In detail, Al-Hisbah has some functions such as to
control the quality, shariah, moral, environment and health. This legislation must
ensure that there is no monopoly in the market. Further, the most important tool in
Islamic market regulation is pricing aimed to avoid inflection of injustice giving
negative effect on the market. Subsidies, licensing, registration and the use of iqta,
ihya and hima are the direct tools in Islamic market regulation.

4.2. Islamic Financial Architecture

4.2.1. The Evil of Interest Rate
The issue of the tools of market regulation in Islam is derived from the God
revealation consisting of 2 parts, which are Maqasid al-Shariah and few issues in
Shariaah rulings. Here, the few issues in sharia rulings deal with the government
interventions in the market, e.g., establishing al-hisbah (ombudmanship). Since Islam
does not admitted trading money for money, hence the fiat-money (paper money) is
not admitted. Debt crisis occurred in Eurozone in the middle of 2008 is a product
created by the working of compounded fiat-money interest rate as what happened in
Iceland.The debt crisis in Iceland was mainly due to higher external debt in view of
the failure of the banking sector. It was supported by easy access to cheap money
from abroad that have primarily been driven by borrowing from the corporate,
government (to finance government spending) and household sectors (domestic
consumption). Net debt as percentage of GDP in 2009 was climbed to 55.79 percent
compared 7.81percent in 2006 (IMF World Economic Outlook, 2006 to 2009). This
condition indicates that in 2009 the confidence of investor significantly dropped in
terms of Iceland ability to service its debt. The presence of interest portion on debt
creates the total debt compounded. Since a country fails to follow the increasing of
total debt along with interest rate by producing more output, hence the money supply

18
rises beyond the growth of their output (GDP). As its concequence, the rate of
inflation rises faster and creates the crises.

Graph 1
M2 and Real GDP in Iceland
6.2
6
Log Ms and Log GDP

5.8
5.6
5.4
5.2
5
4.8
4.6
2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010
Log GDP Log M2

Source: Central Bank of Iceland. Authors calculation.

The economic condition of a country can be observed by comparing the

growth of money supply and real GDP. From three graphs (1) below, we can be
clearly seen that the money supply is much higher than real GDP. In this case, if the
growth of money supply is higher than the growth of real GDP, it means that the
inflation rate of this country is very high. In the other words, this country will be
experiencing severe economic problems. To determine both of the growth money
supply and real GDP, we can also employ geometric mean.

19
 Table 1
Growth of GDP, MS and Inflation Rate in Iceland (2000-2010)
Percentage
Growth of GDP (i)* 2.18%
Growth of Ms (i)* 21.51%
Inflation rate 18.91%
Source: Central Bank of Germany, Central Bank of Iceland and IFS. Authors
calculation. (*computed by Geometric Mean

Table (1) summarizes the result of geometric mean computation showing the
growth of money supply in Iceland is higher than the growth of real GDP and the the
inflation rate reaches 18.91 percent. Following the established equation (1) and (2),
the regression analysis is carried-out based on natural logarithm (Ln) model. Table
(4) shows that the estimated coefficient of M1 in Iceland is much higher than the
estimated coefficient of GDP. This result also supports the finding of geometric
computation as stated earlier. In other words, there is an economic problem, in
Iceland, i.e., worst economic crisis.

Table 4
OLS Estimation
GDP MS
C -48.18682 -449.1282
(11.32425) (36.14156)
Iceland
Year 0.030818 0.230364
(0.005648) (0.018026)

Source: Central Bank of Iceland and IFS. Authors calculation. Standard error in parentheses.

4.2.2. Basic Islamic Financial Framework: Free Interest Banking

The most crucial objectives of Islam is to be aware greater justice in human society.
The absence of justice in a society will ultimately create destruction (Quran 57:25).
Justice needs a set of rules or moral values accepted and trully agreed by every

20
individual in the society.The financial system may be able to promote justice if in
addition to be strong and stable. It satisfies at least two conditions based on moral
values (Adel, 2010). First, the financier should also share in the risk so as not to shift
the entire burden of losses to the entrepreneur. Second, an equitable share of financial
resources spread by financial institutions should become available to the poor to help
alleviate poverty, expand employment and self-employment opportunities and, thus
it will reduce inequalities of income and wealth.
To fulfill the first condition of justice, Islam requires both the financier and the
entrepreneur to equitably share the profit as well as the loss. To do so, the basic
principles of Islamic finance admits no risk, no gain. This should help introduce
greater discipline into the financial system by motivating financial institutions to
assess the risks more carefully and to effectively monitor the use of funds by the
borrowers. Contrastingly, conventional system recognizes interest rate which is the
same as riba. Islamic financial system strictly prohibits riba in its transaction since it
is clearly stated both in Quran and Sunnah.
Fundamentally, the developmental role of Islamic banking and finance is almost
similar with its conventional counterparts. Both financial intermediaries offer to
mobilize savings from the surplus sector and conduct a credit allocation function to
the deficit sector. The most impotant difference being in the nature of financial
contracts applied in these markets. For example, in Islamic banking, the contract of
al-bay' (selling) changes the contract of loans. The prominent issue for this
replacement is the prohibition of interest as riba. The payments and receipt of interest
must be avoided by deposit taking and financing activities due to one of the reason as
always related with the distributional issue that has often been used to explain the
evils of riba. Since profits from riba or interest are created without the existence of
'iwad (an equivalent countervalue) riba constitutes an unlawful gain as it is created
without risk-taking and value-addition activities (Haque, 1995).
Literatures on Islamic banking often state that people or institutions who benefit
from riba conduct so without taking work and effort into the business transaction.

21
These return is contractual in nature that lenders hold a legal claim. Lenders are
allowed to fail to make full repayments of capital and interest to do legal action
against borrowers. Bankruptcies and business closure are common examples of
punitive damages of the interest system. When capital owners are permitted to create
wealth in this way, they become richer by virtue of the capital accumulation in which
the de facto machine is interest. On the other hand, people who joint to risk-taking
and value addition (the borrowers) are bound by the law to repay both capital and
interest even if the business fails to obtain profits. It can be seen that in the long-run
period the distribution of income will work in favour of the lending sector.
The European economic crisis, like in Iceland, showed message to this. May debt
ridden companies gets back no protection under a regime where defaulters are
punished discretely even if they can still perform a positive role in economic
development. For instance, it is common work among banks to accept stocks as
collaterals on loans. Banks recall loans were seen by the stock market meltdown
across the emerging market countries in 1997 when the value of collaterals
depreciated. It halted factory operations leading to colossal layoffs and loss of
income. Under a collapsing currency system are too acutely suffered by borrowing
via the bond market. Depreciation of currencies arise from panic selling of stocks and
it is followed by short-selling of affected currencies impact on borrowers in a big way
as they must continue to pay debt in hard currencies.

5. Conclussion
Islamic state will be estabilished since the shariah law is able to be properly
implemented. People not only live for this life (duniya), but also they have to
consider for hereafter (akheerat). Thus they have to allow everything in the sake for
Allah by following Shariah principles. In this context, Shariah principles will be
administered when the ruler or government purposes solely for worshiping to Allah.
Unfortunately, not all of moslem country choose to authorize Shariah principles as
base of law. Lineback (2005) divides a state where moslem becomes majorities into

22
four categories, namely Islamic states, Islam as the state religion, States whose
constitutions simply do not declare any religion, States declared as secular states
whose constitutions acknowledge the diversities of religions within their borders.
These first two groups are considered the core of Muslim counties across southern
Asia and North Africa.
Reffering to these categorization, the Islamic state will be established since
the agent deals with Islamic values, i.e. Islamic government. The existence of interest
rate in the moslem countries economy has implicitly proven that the power of Islamic
government is absent in this world. Here, the need of siyasah shariah to build
Islamic government before establish Islamic state becomes an obligatory. Since the
politic system is under Islamic law, hence the governance of all transactions in
society will invoke with shariah rulings, including economic activities. In economic
matters, for example, it is important to avoid riba or interest since its tenet is contrary
with justice, one of the main principle that have to be cared of. Moreover, interest is
clearly forbidden both in Quran and Sunnah, thus Islamic state is crucial issue to be
paid attention by the moslem citizen. Debt crisis occurred in Eurozone in the middle
of 2008 is a product created by the working of compounded fiat-money interest rate.
Iceland, for instance, has been at the centre of the Eurozone debt crisis by having the
highest levels of public debt and one of the biggest budget deficits. It has been proven
by geometric mean and OLS that interest rate is the root cause of economic disaster.
Since Islam does not admitted trading money for money, hence the fiat-money (paper
money) is not admitted.
In Islamic state concept, the establishment of Al-Hisbah (ombudmanship)
becomes an obligatory due to safeguards the moral value of shariah in economic
activities and to promote the boundaries of what is known as good and as bad. The
major function of al-hisbah is to control the quality, shariah, moral, environment and
health. Technically specaking, the muhtasib (ombudsman) will supervise market from
three sides, namely (a) all of activities and transactions must under the rules of
shariah, (b) all of activities and transactions have to fulfill the moral value of Islam

23
as a belief system (c) the ombudsman (Muhtasib) is also assigned with the task to
ordain what is known as good and as bad. Thus, this legislation will ensure that
there is no monopoly in the market.

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